The Case For Registered Reverse Mergers

I spent a couple days at Deal-Flow Media's Reverse Merger Conference in Los Angeles last week and left Thursday afternoon with the firm conviction that while competitors and colleagues are working diligently to develop new reverse merger structures that accommodate recent regulatory changes, most of the emerging structures are too complicated, contingent, time-consuming and expensive for the real world.

After listening to hours of presentations on APOs, WRASPS, Virgin Shells, direct filings and other emerging structures, I'm more convinced than ever that there are only two rational IPO alternatives. The first is a reverse merger with a legacy shell that will be registered with the SEC on Form S-4. The second is a reverse merger with a Rule 419 shell that will use a post-effective amendment to an existing SEC registration statement to achieve the same result.

Over 28 years of practice in the small company finance space have taught me four great truths:

• No sane management team even considers going public unless they need money and their investors demand the liquidity of a public market;
• Our clients never believe that OTCBB or Pink OTC quotations represent fair markets that reasonably value their stock;
• Institutional investors avoid OTCBB and Pink OTC companies like the plague unless their investment will serve as a spring-board to a national exchange listing; and
• Companies that begin trading on the OTCBB or Pink OTC markets often find it very difficult to develop the corporate bulk and shareholder base required to upgrade to a national exchange.

While there are rare exceptions, we believe private companies should not go public without a clearly defined short-term plan to list their shares on a national exchange like the Amex or Nasdaq. Anything less is the self-inflicted pain of OTCBB purgatory or Pink OTC hell.

If a private company has ready access to adequate capital, the documentation for an SEC registered reverse merger is not much more complicated than the "Super 8-K" filing required for every reverse merger. The big difference is that an SEC registered reverse merger is a one-step process that does not entail the time and expense of:

• filing a Form 10 or Super 8-K and clearing SEC comments;
• filing a Form 211 quotation application and clearing FINRA comments;
• filing a resale registration statement and clearing SEC comments; and
• working to develop a stable market on the OTCBB or Pink Sheets.

Instead you file a registration statement on Form S-4 (or a post-effective amendment for a Rule 419 offering) and concurrently file a listing application with a national exchange. Once you clear SEC and exchange comments, you can close the reverse merger and immediately begin working to develop a credible trading market on a national exchange.

Unlike the more convoluted emerging structures, an SEC registered reverse merger puts all shareholders of the combined companies (other than directors, officers and affiliates) on an equal footing because they all end up holding shares that can be resold in the public markets. There is no discrimination between new money and old money, and the potential for market manipulation that invariably arises when a small group of shareholders control the bulk of the public float effectively disappears.

I cannot overemphasize the difference between a back-door reverse merger, which invariably gives rise to substantial regulatory and market skepticism, and a front-door reverse merger that simply follows the SEC's rules and takes the shortest path from point A to point B. Full SEC registration is difficult, time consuming and expensive, but so are all of the common reverse merger alternatives. In the final analysis, the securities markets are no place for on the job training and it's always better to learn the rules before you begin playing the game.